Agrochemicals: has external manufacturing become the preferred option?
Rapid advances in quality and scale among Asian manufacturers, most notably in India, suggest new market opportunities by tipping the make vs buy equation.
Rapid advances in quality and scale among Asian manufacturers, most notably in India, suggest new market opportunities by tipping the make vs buy equation. Arun Kochar (partner), Oliver Zeranski (partner), Rajeev Prabhakar (partner) and Drew Rattigan (manager) from consulting firm AT Kearney explore changing paradigms in manufacturing decisions.
Rapidly improving capabilities in the emerging markets suggest that it may be time for global agrochemicals companies to take a fresh look at outsourcing the production of active ingredients and even partnering in joint product development. Past concerns about quality, reliability and intellectual property protection are easing as Asia-Pacific suppliers raise their game and alter the external manufacturing equation for companies looking to manage costs, shorten product cycle times, and enter new markets.
As developed economies and agrobusiness multinationals move up the value chain using big data, satellite imaging, plant genetics, drones and other technologies, traditional agriculture in developing markets is likewise under pressure to modernise. Farming operations urgently need to feed a growing population and meet rising consumer expectations for food quality and variety. Similarly, agrochemical suppliers are consolidating to achieve scale and diversifying product offerings to meet domestic and export demand. Lacking the capex resources to invest in R&D, these agrochemical suppliers are defending their home turf via growth through acquisitions, specialisation and contract manufacturing. Governments are stepping in with economic and regulatory changes to support industry transition.
The outsourcing of raw materials, components and assembly of finished products has long been common in sectors from apparel to electronics to software and even, more recently, pharmaceuticals. Generally, the trade-off centers on turning over specific legacy or non-core sourcing and production functions to a partner who can perform these activities more efficiently with comparable or higher quality at a lower cost. This, in turn, frees up assets and working capital for higher-end, more profitable operations that better reflect the company's future direction. Agrochemicals producers have been slower to embrace external manufacturing partners in their supply chains because of the added liabilities and concerns that they face relating to quality control, intellectual property, regulatory requirements, and environment, health and safety (EH&S) compliance.
But the market landscape is changing. As global fertiliser and pesticide producers face mounting costs and regulatory constraints, emerging market manufacturers are drastically improving the quality of their operations, making them well-positioned to pick up the slack in select cases.
The Make vs Buy Equation
A complex competitive landscape of rising materials, labour and environmental compliance costs, paired with slow demand growth and thin margins in traditional markets, is gradually forcing global agrochemical producers to rethink top-line growth strategies currently focused on internal manufacturing and intellectual property protection. More producers are now considering profitable growth strategies that rely on external contract manufacturing partnerships to manage costs for lower-end product lines while entering new markets with a broader set of products.
The risks inherent in making such a transition vary by company and product. Agrochemical producers need a comprehensive set of standardised criteria for evaluating products for their external manufacturing suitability, and a process that engages product managers across the entire portfolio to identify and prioritise external manufacturing opportunities, keeping in mind the broad spectrum of strategic options available:
End-to-end internal manufacturing. Raw materials for intermediates and actives are sourced from suppliers and all major intermediates and actives are manufactured in-house.
Limited external manufacturing. Critical reactions for active ingredients, involving cutting-edge technology and IP protection, are kept in-house, whereas intermediates and off-patent ais are sourced from a small set of core suppliers, with selective technology sharing.
Segmented external manufacturing portfolio. Multi-dimensional criteria evaluate external manufacturing for all intermediates and ais to maximise profitability; a constantly updated and segmented list of external manufacturers is managed via a clear strategic resource management (SRM) process; and joint venture or similar relationships enable sharing of robust technology packages.
End-to-end external manufacturing reliance. All major intermediates and ais are manufactured by external manufacturers; the company sets and monitors external manufacturer service levels and compliance to quality, purity and other technical standards.
It is important to conduct a comprehensive review of the company's entire product portfolio, subjecting each product to the same set of criteria, including products that may already be externally manufactured. Product external manufacturing opportunities are best evaluated for their strategic and financial value, in four dimensions:
What will be the outsourcing impacts on current competitive advantages such as technical strength, scale, branding and market access, and IP protection?
What will be the impacts on current and future operations, in terms of lost in-house capabilities, capacity constraints and environmental, safety, regulatory and reputational risk?
Is the supplier market mature and ready in terms of size, available capacity, expertise and capabilities, in a market environment of strong buyer power?
Is there sufficient financial upside in terms of current and future profitability, cost spillover, investment appetite, asset performance and return on capex investment?
A scoring methodology for evaluating individual products across the four dimensions – competitive advantage, operational impact, supply market readiness and financial upside – is critical for assessing potential benefit for each product and prioritising outsourcing across the portfolio.
It should be kept in mind, too, that the relevance of each dimension will vary by product: and its particular stage of development:
The Diagnostic Process
A focused make-versus-buy business case begins with a three-step diagnostic approach, which entails: 1) Gaining a full understanding of the company’s product portfolio, aligning with portfolio manufacturing leaders on a diagnostic methodology and developing a list of molecules for preliminary assessment; 2) scoring the portfolio of molecules with feedback from product leads and relevant stakeholders to develop a shortlist of candidate products; and 3) analyse each product's competitive positioning, interdependencies with the rest of the portfolio, the external manufacturing supplier landscape and the external manufacturing business case. This process takes approximately 12 weeks to complete.
The overall business case should be driven by a clear set of guiding principles – ensuring supply, improving competitive position, hedging against risk, protecting intellectual property and market intelligence, balancing near and long-term value, and so on – as applied to key baseline information such as strategic planning goals and objectives, technical product data, internal capabilities and global regulatory requirements.
A screened list of suppliers can then be assessed for their relative capabilities through a process of questionnaires and site visits. Technical questionnaires are used to define requirements for manufacturing and materials handling without disclosing specific product details in the early stages of review. In addition to technical capabilities, the process should evaluate production capacity, IP protection, EH&S standards, and current registrations for actives among other factors.
Shortlisted suppliers are next invited to participate in a formal request for proposal (RFP) process. As the 'buy' analysis moves forward, the 'make' model is revised and validated, filling in any input gaps that may have appeared to date. As a final stage, the make-versus-buy comparison is fine-tuned with:
A detailed, apples-to apples price comparison of landed costs;
An evaluation of different savings and net present value scenarios (make, buy, hybrid mix) based on prices and in the context of guiding principles;
A financial assessment weighing tax, inventory/working capital, organisational, resources and one-time cost impacts, and
A risk assessment of the external manufacturer's ability to perform in terms of delivery commitments, registrations and permits, quality standards and supply chain continuity.
Agrochemical producers face difficult strategic choices as they navigate maturing home country markets, rising material and labour costs, trade and regulatory uncertainty and climate change impacts. Optimising supply chains, product mix, service levels and cost structure as they scale up to enter new markets inevitably raises tricky global partnership questions. Solutions vary widely by country, partner, and finished product or ingredient, with the potential for significant external manufacturing benefits as well as risks. But there is cause for optimism – with increased global investment in plants, equipment, processes, and technology, emerging market production quality and reliability have come into closer alignment with developed country standards, revealing new partnership opportunities.
The key to making smart external manufacturing partnership decisions is, first and foremost, good planning. A full understanding of baseline operational capabilities, a clear long-term vision for the future and a sound methodology for weighing available options together help clarify risk and provide the road map for a successful path forward.